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Tax Discounts on property investments

News date: Monday, 15th of August, 2005

TAKING A SIPP

On 6 April
2006, named A-Day by the Inland Revenue, changes in pensions’
legislation, particularly SIPPs, will come into being, entitling you to
buy a residential property overseas with tax discounts of up to 40%,
reports financial writer Gordon Miller

April 6 2006 sees the biggest shake up in pensions in the UK for over
100 years. One of the most radical reforms is in self-invested personal
pensions (SIPPs), hitherto a pension trust utilisable by only the
seriously wealthy that, with certain provisos, entitles anyone to
purchase a residential property overseas through a SIPP and receive
favourable tax breaks, up to as much as 40% for higher rate tax payers.

Senior partner John Howell, at solicitors John Howell & Co has
described the SIPPs changes as a major opportunity for consumers to buy
property overseas at beneficial rates. “The number of registered SIPPs
is expected to increase from 120,000 to several million,” he says.
“Many of those will choose to invest in real estate with many of them
electing to do so internationally. It is an area of great potential for
those seeking property abroad.”

Less than a year before the legislation becomes statute, SIPP’s rules
and regulations are far from finalised, as Adrian Ware, managing
director at Cavendish Ware, a specialist pensions adviser, explains,
“The legislation requires clarity in certain areas which will happen in
advance of A-day. However one area that purchasers can exploit, in
principle, is buying off-plan,” he says. “An individual can agree to
exchange off-plan personally now, and then complete through the pension
plan post-A-Day, giving a significant opportunity for capital growth in
the value of the property, and the pension scheme.”

Effectively, the legislation as it stands, a fact corroborated by John
Howell, is that a client may buy a property off-plan today, pre-6 April
2006, in the name of the SIPP, providing the property is not delivered
until after A-Day. “Anybody buying a property off-plan is not buying a
residential property because that off-plan property is not going to be
delivered until after April 2006,” he says, “and it is okay therefore
to buy that property in the name of your SIPP right now.”

Manchester-based agents Assetz have been quick to capitalise on the
‘loophole’, noting that off-plan purchases give the best opportunity to
maximise profits. “SIPP investors will benefit from full UK income tax
relief on the purchase price of the property, before going on to
collect rental income tax-free in the UK in the pension fund,” says
Stuart Law, managing director of Assetz. “Any profits made from the
sale of the property will also be free from UK capital gains tax (CGT).
What’s more, the pension fund will be able to borrow to invest, so
buyers will be able to gain access to holiday homes that would have
otherwise been out of their reach.”

At present a SIPP may borrow up to 50 per cent of the value of the
fund. So if the SIPP’s value is £52,000, it may borrow an additional
£26,000, a total of £78,000, that with the tax benefits of a minimum of
22 per cent means it will be able to buy a property priced £100,000.
Higher rate taxpayers, who will receive 40 per cent tax relief, will
only be required to pay in £40,000, borrowing an additional £20,000 in
order to buy the similar £100,000 priced property. The extra tax relief
for higher rate tax payers, allied to the fact that no CGT will be
chargeable in the UK on a sold property, has led observers to speculate
that the treasury effectively will be giving away £4 billion in tax
concessions.

CGT and trust law, however, remain an area of contention for those
looking to buy a property overseas through their SIPP. “One of the
critical aspects for people looking to use a SIPP to invest in overseas
property is the whole tax issue: while in the UK all CGT is zero-rated
for pensions the same is not (automatically) true, for example in
Spain, where SIPPs and trust laws don’t exist,” says Tony Morris of
Costa Blanca agents Dragonfly. “The upshot could be that homeowners who
sell up could be exposed to the Notario who, as things stand, will want
his 35 per cent CGT in Spain.”

In all likelihood CGT will remain payable in the host country should
you sell up, but you will not be liable to pay CGT in the UK, as one
does at present, providing the property is owned and sold by the SIPP.
(Should you sell a property as an individual you will remain liable for
CGT in the country where the property is owned in addition to the UK.
In effect, assuming a double taxation treaty is in place you will only
pay CGT once, usually in the UK, where the rate is higher than in most
other countries.)

Tax relief aside, buying through an overseas property through a SIPP
may not be the best route for everyone. Take, for example, retirees or
semi-retirees, who plan to use their property frequently. One of the
SIPP conditions stipulates that anyone using the property must pay the
pension fund rent to the value it would achieve on the open market.
While this in itself may not be a problem – because ultimately you will
be the beneficiary of the SIPP - it may tie up sorely needed cash and
even should you sell up to release cash, you will not be able to
withdraw any money paid into the SIPP before you are 50 years of age or
55 from 2010; even then you will only be permitted to withdraw 25 per
cent as a lump sum. The imposed conditions mean that while purchasing
through a SIPP may at first seem a highly attractive option, ultimately
it may not be the route to owning a property overseas for everyone, as
Kim Crossley of Napier International outlines.

“SIPPs are expensive compared to stakeholder pensions in traditional
funds,” she says. “The pension fund should not put all its eggs in the
overseas property basket and funds should not overstretch themselves
with loans. The minimum we recommend to invest in this market is an
£80,000 fund, investing, say, £40,000 with an equivalent loan to buy a
lettable holiday property for £80,000, which is approximately €110,000.
At this level the charges will be cost-effective and reasonable.”

SIPPs providers’ management fees and commission structures vary
depending on the sums invested, but at the above entry level figures,
clients could reasonably expect to pay 0.5-1% per annum of the fund’s
value, a not prohibitive sum when the tax benefits are underlined. “If
SIPPs investment is done properly then it has great potential. The tax
breaks are fantastic and it is a huge opportunity to use existing funds
to buy residential and overseas property,” says John Howell. “ But it
is essential that investors get the right advice and assistance in
order to maximise these benefits.”

SIPPs: A 60-second guide

What is a SIPP?

A SIPP is a self-invested personal pension that allows an individual to
manage his own pension. Previously only utilised by the very rich, a
change in Inland Revenue pension rules from 6 April 2006 means that
anyone who sets up a SIPP can invest in a wide range of items,
including residential property in the UK or overseas.

What are the benefits of having a SIPP?

Tax relief. All UK pension contributions attract tax relief and for
every 78p paid into a pension scheme the government pays in 22p.
Additionally, higher rate taxpayers receive an extra 18p in every £1,
meaning they would receive 40p in every £1 or 40% tax relief on any
property bought.

Who benefits the most?

Higher rate tax payers (those who earn in excess of £32,400) will
benefit most but everyone will benefit from 22% tax relief, meaning if
a client buys a property priced £100,000 through his SIPP it will only
cost him £78,000.

What regulations are there?

Number one is that any property bought via a SIPP will be owned by the
SIPP and not by the individual although he can be the beneficiary of
the SIPP once he reaches 50 years of age or 55 from 2010.

Can the owner use the property himself?

Yes, the property may be used by the individual as long as he pays a
commercial rent in the same way anyone else using the property would.

Are there any other qualifying conditions?

If the property is sold the individual will not be able to access the
cash until he is 50, or 55 from 2010, when he will be able to take out
25% of the fund as a tax-free lump sum and the balance to produce a
taxable income.

Are taxes, including Capital Gains Tax (CGT), payable?

Not in the UK. However, if the property is abroad, you will have to pay
local tax on rental income and should the property be sold, CGT if it
is applicable in the country where the property is located.

Are there any other issues with SIPPs owning a property abroad?

Some countries, including Spain and France, recognise individuals and
companies being able to own a property but not a trust, which is
effectively what a SIPP is. The issues surrounding trust status and
property ownership overseas, we are told, will be clarified prior to
A-Day.

Can a SIPP borrow money?

Yes, the SIPP will be able to borrow, subject to status, up to 50% of
the value of the fund. For example, if you are a lower rate taxpayer
and want to purchase a £100,000 property you would need to raise
£78,000 (22p in the £1 is the tax relief), 50% of which (£39,000) may
be borrowed against the SIPP.

How can I pay into a SIPP?

You can contribute the equivalent of all your earnings to the SIPP up
to a maximum of £215,000 per year and £1.5 million in a lifetime. Also,
you can begin contributing to a SIPP now ahead of the 6 April 2006
commencement date.

Who administers a SIPP?

A SIPP is regulated by a manager (effectively a trustee of the
pension), whose legal responsibility it is to ensure that the SIPP (and
therefore the property) is run properly.

Can I transfer my current personal pension into a SIPP?

Yes, you may transfer your existing personal pension into a SIPP; the
SIPP provider will administer the transfer that they will then manage
on your behalf.

How much do SIPP providers charge?

It varies, but if an individual has approximately £100,000 in the fund
between 0.5-1% of its value per annum is the going rate.

Can I transfer my current overseas property into a SIPP?

Yes, although the SIPP will have to buy it from you personally, meaning
CGT is likely to be payable on any profit. It may, however, be
financially worthwhile doing so. Seek independent financial advice,
bearing in mind that stamp duty and other legal and financial fees will
be borne by the SIPP and need to be factored into the costs.

Are there any special rules regarding off-plan purchases?

Yes, off-plan purchases made by an individual now can be transferred to
his SIPP after 6 April 2006, enabling you to take advantage of the
potential capital gain between now and A-Day.